Hill Motor Company, one of the country’s largest automobile manufacturers, disclosed the following information about its inventory in the notes to its financial statements:
Inventories are stated generally at cost, which is not in excess of market value. The cost of inventory is determined by the last-in, first-out (LIFO) method. If the first-in, first-out (FIFO) method of inventory valuation had been used, inventory would have been about $2,519 million higher at December 31, 2011, and $2,668 million higher at December 31, 2010. As a result of decreases in inventory, certain inventory quantities carried at lower LIFO costs prevailing in prior years, as compared with costs of current purchases, were liquidated in 2011 and 2010.
These inventory adjustments improved pretax operating results by approximately $134 million in 2011 and $294 million in 2010.
Required:
1. Explain why the reduction in inventory quantities increased Hill Motor Company’s net income.
2. If Hill Motor Company had used the FIFO inventory costing method, would the reduction in ending inventory quantities have increased net income?